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How Sensitive Are VAR Forecasts to Prior Hyperparameters? An Automated Sensitivity Analysis

^aPurdue University, United States

^bUniversity of Melbourne, Australia

^cMonash University, Australia

Topics in Identification, Limited Dependent Variables, Partial Observability, Experimentation, and Flexible Modeling: Part A

ISBN: 978-1-78973-242-9, eISBN: 978-1-78973-241-2

Publication date: 30 August 2019

Abstract

Vector autoregressions (VAR) combined with Minnesota-type priors are widely used for macroeconomic forecasting. The fact that strong but sensible priors can substantially improve forecast performance implies VAR forecasts are sensitive to prior hyperparameters. But the nature of this sensitivity is seldom investigated. We develop a general method based on Automatic Differentiation to systematically compute the sensitivities of forecasts – both points and intervals – with respect to any prior hyperparameters. In a forecasting exercise using US data, we find that forecasts are relatively sensitive to the strength of shrinkage for the VAR coefficients, but they are not much affected by the prior mean of the error covariance matrix or the strength of shrinkage for the intercepts.

Keywords

Acknowledgements

Acknowledgment

We would like to thank Jackson Kwok for his excellent research assistance.

Citation

Chan, J.C.C., Jacobi, L. and Zhu, D. (2019), "How Sensitive Are VAR Forecasts to Prior Hyperparameters? An Automated Sensitivity Analysis", Topics in Identification, Limited Dependent Variables, Partial Observability, Experimentation, and Flexible Modeling: Part A (Advances in Econometrics, Vol. 40A), Emerald Publishing Limited, Leeds, pp. 229-248. https://doi.org/10.1108/S0731-90532019000040A010

Publisher

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Emerald Publishing Limited